RealNetworks, Inc.
Q3 2014 Earnings Call Transcript

Published: 4 Nov 2014

[Operator:]

Welcome to the RealNetworks third quarter 2014 earnings call. (Operator Instructions). I would now like to introduce our first speaker, Drew Markham, please begin.

[Drew Markham:]

Thank you Sharon and welcome to the RealNetworks third quarter 2014 conference call. Before we begin, I remind you that some matters discussed today are forward-looking, including statements regarding RealNetworks' future revenue, expected EBITDA, earnings and operating expenses and trends affecting its businesses and prospects for future growth and profitability. Other forward-looking statements include the company's plans to implement its strategy and invest in its products and initiatives, as well as the expected growth, profitability and other benefits from those activities. All statements other than statements of historical fact are forward-looking and involve a number of risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. We describe these and other risks in our SEC filings. A copy of those filings can be obtained from the SEC, or from the Investor Relations section of our corporate website. These forward-looking statements reflect RealNetworks' expectations as of today, November 3, 2014. The company undertakes no duty to update or revise any forward-looking statements made during this call, whether as a result of new information, future events, or any other reason. We will present certain financial measures on this call that will be considered non-GAAP under the SEC's regulation G. For a reconciliation of these non-GAAP financial measure to the most directly-comparable GAAP financial measure, please refer to the information included in our press release and in our Form 8-K dated and submitted to the SEC today, both of which can be found on our corporate website at Investor.RealNetworks.com, under the tab financial information. Here with me today are Rob Glaser, Chairman and CEO; and Tim Wan, CFO. Rob will discuss company strategy and the progress the company has made in recent months and Tim will provide a financial review of the third quarter and the outlook for the fourth quarter of 2014. After their prepared remarks, they will be pleased to answer questions. Now, I'll turn the call over to Rob.

[Rob Glaser:]

Thanks Drew. Good afternoon, everyone and thanks for joining us. Today, I give you an update on our progress in turning around RealNetworks and putting the company on a path to achieve sustainable growth, user engagement, revenue and profit. I have four topics to discuss, first, the progress of our most important new initiative, RealPlayer Cloud. Second, our recent launch of Slingo Adventure which is our most important new initiative in our games business; third, our efforts to reduce operating expenses and manage costs in our non-core legacy businesses, and fourth, our continued progress at Rhapsody. First, RealPlayer Cloud, at our last earnings call, we provided some early metrics on RealPlayer Cloud and indicated that we believe it to be the cornerstone of our efforts to revitalize RealNetworks. We continue to make strong progress in most of the key metrics we track regarding RealPlayer Cloud. Earlier today, we announced that over 8 million users have both downloaded the RealPlayer Cloud app and established Cloud accounts, that's up from 5 million just three months ago and 0.5 million at the beginning of the year. RealPlayer Cloud is truly a global product; it's available in 40 countries and running on 12 different platforms, including the just-released native Mac version. We’re also seeing good growth in our basic users, who have subscribed to one of the premium versions of RealPlayer Cloud and we now have tens of thousands of paying customers. In commemoration of our one-year anniversary of launch of RealPlayer Cloud earlier today we launched a promotion to provide customers who buy premium RealPlayer Cloud a whopping 365 terabytes of storage for just $4.99 a month. Going forward, we still have a lot of work to do to capitalize on early momentum with RealPlayer Cloud. We need to continue to rapidly enhance the product and to bring it to even more languages, countries and devices. We need to engage with partners who integrate RealPlayer Cloud with their service offerings and we need to continue to drive consumer adoption of both our free and premium RealPlayer Cloud offerings. Nevertheless, we're very encouraged by what we've achieved in a short period of time. RealPlayer Cloud is certainly one most successful new product launches of 2014 and represents the cornerstone product of the new RealNetworks. The second topic I want to discuss, the progress we made in our games division specifically our successful launch of Slingo Adventure. In September, we launched Slingo Adventure or Facebook worldwide and then a few weeks ago, we shipped the iOS and Android versions of Slingo Adventure. Slingo Adventure is an important milestone for us in many ways. It's the flagship product coming out of our acquisition of Slingo in mid-2013. It's also the first free-to-play premium game that we developed in-house and deliver on all three major social platforms; Facebook, iOS and Android. While it’s too soon to declare victory, based on the early results, we're optimistic that we can successfully scale Slingo Adventure to reach a large and loyal audience, who monetize at or above our goals for the product and create a franchise property for our games business. Third, I want to talk about our cost reduction efforts in the third quarter. As you know, we're in transition from our revenue being driven primarily by legacy businesses, to a business driven by growth initiatives involving our new multi-device Cloud-based products. Further, as we discussed at our last earnings call, two of our legacy revenue streams, IP licensing and download partner revenue took unexpected hits to revenue and profit earlier this year. To mitigate this impact, we reduced our operating expenses related to our non-core legacy products to over $15 million on an annualized basis. This includes a reduction of our workforce by approximately 100 during the third quarter. We're making these costs and staffing cuts so that our legacy businesses continue to make sense to us financially as well as strategically. We'll continue to make significant investments in our RealPlayer Cloud business and to a secondary degree our Slingo product line. We expect that our new products, initiatives, investments and leadership will lay the foundation for long-term growth and profitability. In general, our approach is to build a strong foundation and to create a large and vibrant user base that we will monetize over time. This strategy has been used successfully by a number of excellent companies in recent years, such as Facebook, Twitter and Dropbox. While it's still early in the lifecycle of RealPlayer Cloud and even earlier on Slingo Adventure's lifecycle, we're seeing progress in the key metrics that typically lead to successful monetization. Fourth, I would like to provide an update on Rhapsody, a leader in online music services and a company which we own about 45% of. As you know, my colleagues and I are continuing to work closely with the company to drive its business forward. Recently, Rhapsody brought in a few executives who we've been affiliated with [Real to] [ph] help Rhapsody scale most notably Dave Hose as acting CEO. We continue to be encouraged by Rhapsody's progress and year-over-year revenue growth of 25% and the positive trends as digital music moves away from individual track sales and towards streaming and subscription services. We think Rhapsody is on a path to create significant value. And with that, I'll turn the call over to Tim to review the financials.

[Tim Wan:]

Thanks, Rob. For the third quarter of 2014, our total revenue was $34.2 million, compared to $40.8 million in the previous quarter and $49 million in the third quarter of 2013. As Rob said, we have continued to execute on our strategic transition, investing in our new business initiatives and focusing on building a stronger foundation for future growth and profitability. Throughout the process of rebuilding our businesses, we have continued to allocate our resources and capital in a way to maximize long-term growth. We have continued to reduce our operating expenses and reinvest it in new product innovation, in each of our business segments. Because our new initiatives are taking time to monetize and scale, we will continue to manage expenses tightly in the coming quarters. During the third quarter, our combined gross margins were 45%, down from 49% in the previous quarter. This decline is primarily due to two factors; the change in the economics of our distribution of third party software products and codec licensing, both of which I will address in more detail when discussing the RealPlayer Group results. Adjusting for restructuring charges, our total operating expenses decreased 11% versus last quarter, as a result of our expense realignment effort and lower marketing expenses. As Rob mentioned, we took steps in the third quarter to reduce our annual operating expenses, related to our non-core legacy products by over $15 million. Our bottom-line results reflect the ongoing strategic investments needed to revitalize our businesses. Our total adjusted EBITDA for the third quarter of 2014 was a loss of $14.4 million, compared to $8.4 million loss for the third quarter of 2013. While the EBITDA loss for the quarter continues to reflect the decreased revenue from our traditional product lines and continued investment in our growth initiative, it was better than our previous guidance as a result of our cost reduction efforts and some one-time benefits. Now let's look at our quarterly results by business unit, starting with the RealPlayer Group. For the third quarter, RealPlayer revenue was $6.6 million, down 23% sequentially and 63% from the third quarter of 2013. As we've discussed previously, the significant decline in revenue of the RealPlayer business was primarily due to the recent development in our third party distribution and licensing areas. First, a main reason was a change to the economics of our third party software distribution business. A number of companies, including us, have seen continued pricing pressure in the marketplace. We implemented a new third party partner, Ask, in July that balances the appropriate economics while maintaining a great consumer experience. Second, our codec licensing in Asia was weaker than prior quarters due to lower distribution from one of the largest Korean device manufacturers. But we did manage to offset part of the decline by diversifying the revenue stream with other partners and manufacturers this past quarter. This decline reflects the dynamic and ever-changing landscape in the mobile marketplace today. As Rob mentioned, our focus for this business continues to be centered on increasing distribution of the RealPlayer Cloud and monetizing consumers over time. The business model for RealPlayer Cloud is freemium, up to certain level of storage capacity and then a tier subscription fee. While it is still early in the process, we're seeing growth in the number of freemium users becoming paid subscribers. We expect RealPlayer Cloud upsell rates to increase over time and for this ground-breaking product to be a major driver of our future revenue. Adjusted divisional EBITDA for the RealPlayer Group in the third quarter was a loss of $8.8 million. Our mobile entertainment revenue was $19.2 million, down 17% sequentially and 4% from the third quarter of 2013. The sequential decline primarily reflects seasonal variation in systems integration work. Our adjusted divisional EBITDA in the third quarter for mobile entertainment business was $400,000. Games revenue was $8.4 million, down 8% sequentially and 26% from the third quarter of 2013. The decline reflects the ongoing industry-wide transition from PC games to social and mobile games, resulting in lower subscription and unit sales of our traditional products. As Rob mentioned, we're pleased with the early results of Slingo Adventure on Facebook and we just launched Slingo Adventure on iOS and Android. We expect our new Slingo Adventure to be central to our future games business. The adjusted divisional EBITDA for our games business in the third quarter was a loss of $2.2 million. We continue to maintain a strong cash position despite our continued restructuring and capital investments. At the end of the third quarter, we had $178 million in unrestricted cash, cash equivalents and short-term investments. This cash position reflects approximately $1.4 million in severance and other expenses related to our recent cost reduction initiatives in the third quarter. Looking forward to Q4, we expect total revenue of $33 million to $36 million in the fourth quarter. We continue to focus on being disciplined with our operating expenses, even as we make significant investments in support of our new products. Taking all of these factors into consideration, we expect our total adjusted EBITDA for the fourth quarter to be a loss of $16 million to $18 million. Finally, while we’ve not yet fully completed our strategic transition and return to growth and profitability, we have made solid progress on executing our plan to revitalize RealNetworks by reenergizing our business units and continuing to roll out new products and enhanced features. One, we have over 8 million users of RealPlayer Cloud and tens of thousands of paid subscribers. Two, we made significant cost reductions related to our non-core legacy products, while we're continuing to invest in our new initiatives. Three, we’ve successfully launched Slingo Adventure. Four, our financial investment in Rhapsody continues to look promising and five, we still have a strong cash position and valuable assets on our balance sheet and will continue to invest in our business and take advantage of strategic opportunities as they arise. Now Rob and I will be pleased to answer your questions. Operator?

[Operator:]

(Operator Instructions). Our first question comes from Chip Saye with AWH Capital.

[Austin Hopper:]

It's Austin Hopper, can you talk about Rhapsody? And a number of subscribers and some of the success you've had with Telefonica and T-Mobile?

[Rob Glaser:]

This is Rob. Rhapsody's most recent public announcement is it's crossed 2 million subscribers and so we do not in this call, have an update on that. We obviously have rolled out with T-Mobile in the United States, a couple of initiatives. The main one is associated with the unRadio product that we launched with T-Mobile, and Telefonica, we're in Telefonica with several countries in Latin America, the largest of which is Brazil. And I don't have the current count of the number of countries we've announced in, but it's a major part of their footprint in Latin America. And both of those are key strategic partnerships, more generally those kinds of relationships in the Latin America, the U.S. and Europe, have been the main growth drivers for Rhapsody's subscriber and revenue growth over the past year. We’ve a dual strategy, continue to focus in on both the big partners like mobile carriers and also direct-to-consumer models and the approaches reinforce each other and for instance like unRadio which is a product that is available to consumers directly, but in the most significant consumer ways, is partnership with T-Mobile. It's a joint model that works very well. Tim, if you want to add anything particularly beyond that?

[Austin Hopper:]

Sorry, any chance of other relationships with any other major wireless carriers for Rhapsody?

[Rob Glaser:]

Sure. We love wireless carriers at Rhapsody and in fact Mike Mulica, who is now an executive at RealNetworks, is our President of our worldwide sales and business development is also on the Board of Rhapsody. In fact, he joined Rhapsody as an Independent Director and we kept him on the Board when he became an executive at RealNetworks because both we and Rhapsody thought it was very valuable to have someone with that depth of expertise and relationships and knowledge of the carrier world to be involved with Rhapsody. So Mike's been very helpful and it's been great having him involved with Rhapsody.

[Austin Hopper:]

Okay. Could you talk about RealPlayer Cloud? And I don't know how to ask this but customer acquisition costs associated with basically gaining new users? And you did talk about monetization but, give us a sense for at what level you're monetizing users?

[Rob Glaser:]

Tim can speak to whatever we have said publicly about customer acquisition costs. We tend to be, for actually a more competitive reason than anything else, to be fairly circumspect on what metrics we put out about the ramp of the business. We have decided to disclose total number of accounts and that number went up from up 5 million at the end of June to over 8 million now, so we're very happy with that growth. We’ve three or four ways of acquiring customers, we’ve our legacy RealPlayer customers which is a very vibrant channel and a very significant channel. We have the viral use of the product itself which is somebody sees a video that's been shared from somebody else in their social network or their world, through RealPlayer Cloud and we leverage off of that. And those kind of viral loops are gaining. There is still a lot to do to really drive that up, but that's a second method. The third method is public relations, communication. The product is a well-reviewed product, so anytime we get someone to see a review of the product; we're well ahead of the game. And then the fourth is paid acquisition. We do a mix of all those and we love the fact that one of our competitive advantages is that we have that first channel, that very vibrant RealPlayer user base which gives us an ability to have a differentiated product, in terms of additional features it has. It also gives us a way to reach customers that's very economical. Tim, would you want to add beyond that?

[Tim Wan:]

Austin we take a very pragmatic approach. We do look at the lifetime value of our subscribers and we do it, when we acquire subscribers at a profitable basis. Of course because it is a subscription and like many other SaaS business, there is a period of time where that revenue comes in for the subscribers, but we generally take the marketing costs upfront in either bounty scenario. But we're doing it profitably and we measure it very tightly in terms of how we acquire subscribers and measuring the ROI related to that. So operator next question?

[Operator:]

(Operator Instructions). We have no further questions in queue.

[Tim Wan:]

Great, thank you, everyone. We will talk to you shortly.

[Rob Glaser:]

Thanks, everyone. Have a good day

[Operator:]

Thank you. This concludes today's conference. You may disconnect at this time.